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Solar Stock Outlook: Tariffs to Hurt, Cost Cuts a Relief

Rising demand for a carbon-constrained environment along with declining costs of solar technologies should keep the outlook for the U.S. solar stocks favorable. However, the imposition of a 30% tariff on import of crystalline-silicon solar cells and modules by the U.S. government in January and flaring trade tensions with China and America can dampen the growth of the space in the near term.

Per a report by International Renewable Energy Agency (IRENA), solar photovoltaic (PV) modules prices dropped more than 80% in 2009-2017 time frame. Such plummeting costs have prompted other nations like India and Japan to rapidly expand their solar industry. This in conjunction with grid developments has made the solar industry an attractive investment target for big corporate houses, apart from utility providers.

However, Trump's signing of an order to repeal the Clean Power Plan and decision to withdraw from the Paris climate agreement last year made a few analysts skeptical about the near-term growth prospects of the U.S. solar stocks. Nevertheless, abundance of solar energy allows it to score higher than fossil fuels, which are exhaustible. This should keep solar stocks' momentum alive.

Industry Leads on Shareholder Returns

Looking at shareholder returns over the past year, it appears that the current U.S. government's repeated moves against renewables hardly impacted investors' confidence in the industry. Even after revocation of the Paris accord, electric utilities throughout the United States continue to shift toward a clean energy environment.

In fact, a number of coal-fired generators have been closed across the nation. This shows that the growth of the solar industry is inevitable. Moreover, demand for solar energy is projected to rise 20% annually (per the Renewable Energy: United States report of December 2017), indicating immense growth scope in this space. This is encouraging for solar investors.

While the stocks in this industry have collectively rallied 32.6%, the Zacks S&P 500 Composite and Zacks Oils-Energy Sector have gained 14.2% and 15.1%, respectively.

One-Year Price Performance

However, it's worth noting that there was a moderate lack of synchronization in the performance of individual stocks within the group. While the stocks for solar module and panel manufacturers domiciled in China grossly underperformed the industry, thanks to import tariffs imposed on their products; massive surge in prices of U.S.-based solar players like Enphase Energy (ENPH) and SolarEdge Technologies primarily boosted the group's returns.

Moreover, in spite of the simmering trade tensions between the two nations, Chinese companies are maintaining their offshore investments in the United Sates to tap the country's bountiful solar opportunities.

Solar Stocks Trading Cheap

Impressively, even after delivering an outperformance over the past year, the valuation for this industry still looks cheap. One might get a good sense of the industry's relative valuation by looking at its enterprise-to-Sales ratio (EV/Sales), which is an appropriate multiple for valuing investment-oriented stocks like solar.

This ratio essentially measures a stock's current market value, including its debt, relative to its sales value.

The industry currently has a trailing 12-month EV/Sales ratio of 0.77, which is near the median of the multiple's level over the past year. When compared with the highest level of 0.90 and lowest level of 0.56 over that period, there is apparently plenty of upside left.

The space also looks inexpensive when compared with the market at large, as the trailing 12-month EV/Sales ratio for the S&P 500 is 3.03 and the median level is 2.93.

Enterprise Value-Sales Ratio (TTM)

Also a comparison of the group's EV/Sales ratio with that of its border sector ensures that the group is trading at a decent discount. The Zacks Oils-Energy Sector's trailing 12-month EV/Sales ratio of 1.19 and the median level of 1.24 for the same period are way above the Zacks Solar Industry's respective ratios.

Enterprise Value-Sales Ratio (TTM)

Earnings Outlook: A Disappointing Picture

Expanding demand expectations for solar energy along with increasing corporate investments in the solar industry should allow stocks in this space to continue generating positive shareholder returns in the near future.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable measure that can help investors understand the industry's prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company's earnings outlook significantly influences the performance of its stock.

One could get a good sense of a company's earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year's reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.

Unfortunately, neither does the consensus loss estimate for the Zacks Solar industry of 10 cents per share nor does the trend in earnings estimate revisions indicate year-over-year improvement.

Price and Consensus: Zacks Solar industry

Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's earnings potential.

The consensus EPS estimate for the current fiscal year has been revised 23% downward since May 31, 2018.

Current Fiscal Year EPS Estimate Revisions

Zacks Industry Rank Indicates Growth Prospects

The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Solar industry currently carries a Zacks Industry Rank #102, which places it at the top 40% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Solar Stocks Promise Long-Term Growth

While the near-term prospects might not look very welcoming for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Solar industry appears promising. The group's mean estimate of long-term EPS growth rate has been increasing since August 2017 to reach the current level of 17.5%. This compares to 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

Bottom Line

The Chinese government's announcement of a sudden policy makeover on Jun 1, involving a significant cut in subsidies offered to the nation's solar projects, dealt a major blow to the solar industry worldwide. This policy change is anticipated to be detrimental for those U.S.-based solar stocks that have increased commitments to ship modules or are set to construct new projects in China. China's dominance in solar space now poses a serious threat to U.S. based operators, all the more with the imposition of the import tariffs.

Thus, the industry might not be able to tide over the broader challenges in the near term. However, given its favorable industry rank and price performance history, investors may take advantage of the cheap valuation and bet on a few solar stocks that exhibit a strong earnings outlook. However, there remain a few other solar players that are not attractive investment targets.

Below we have mentioned four solar stocks. While two of them have been witnessing positive earnings estimate revisions, it's not the same with the other two.

Azure Power Global Ltd. (AZRE): The stock of this New Delhi, India-based solar energy developer has not made any notable gain in the past year. The Zacks Consensus Estimate for the current fiscal-year EPS reflects a year-over-year improvement of 107%. It sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

Price and Consensus: AZRE

SolarEdge Technologies, Inc. (SEDG): The consensus EPS estimate for this Hod Hasharon, Israel-based solar installations provider moved 9.6% higher for the current year over the last 60 days. The stock has rallied 140.9% over the past year. It carries a Zacks Rank #2 (Buy).

Price and Consensus: SEDG

Yingli Green Energy Holding Company Ltd. (YGE): The stock of this China-based solar photovoltaic manufacturer has declined 24% over the past year. The consensus EPS estimate for the current year remained unchanged over the last 60 days. It holds a Zacks Rank #4 (Sell).

Price and Consensus: YGE

ReneSola Ltd. (SOL): The stock of this China-based solar wafers manufacturer has slipped 0.8% over the past year. The consensus EPS estimate for the current year dropped 50% over the last 60 days. It holds a Zacks Rank #4.

Price and Consensus: SOL

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